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Defense investors fear Trump's plan will meet gridlock

In an October, 2016 file photo, a Lockheed Martin F-35B Lightning II aircraft is silhouetted against the sun during landing exercises on the amphibious assault ship USS America. LOCKHEED MARTIN

Defense investors fear Trump's plan will meet gridlock

by: Aaron Gregg | .

The Washington Post | .

published: March 06, 2017

Donald Trump's presidency was quickly seen as a win for defense companies, who hope to benefit from what the commander in chief has vowed would be a military buildup of historic proportions. But after weeks of euphoric stock valuations, some analysts are warning such optimism could be misplaced given the dynamics in Congress.

"We've tempered our expectations to the low end of the range and believe that the last week of April could devolve into political trench warfare, with neither side budging on priorities," New York-based investment bank Cowen Group wrote in a research note last week. "Trump's repeated promises on defense could hit the same Beltway traffic jam that Affordable Care Act repeal/replace and comprehensive tax reform seem to be stuck in."

Even the increases the White House has touted - which still need to work their way through both houses of Congress - are viewed by some as underwhelming.

The White House said last week it would propose increasing the military's budget by $54 billion, which the White House described as a 10 percent jump in defense spending. But others characterized the increase differently: only about $18 billion more than what the Obama administration had already planned, or a more modest 3 percent boost.

"It's nothing close to the historically high growth rates that this thing had initially been positioned at," said Byron Callan, managing director of Capital Alpha Partners, a provider of research to financial institutions.

The budget increase announced Monday "is a pretty pedestrian increase compared to the Reagan era ... some of these (defense) companies were growing at 15 to 20 percent in the early 1980s," Callan said.

In general, defense investors have been ecstatic at the prospect of having another Republican in the White House, and Trump's campaign statements about adding hundreds of ships and planes to the U.S. military arsenal have only boosted their optimism. The S&P's Aerospace and Defense index has gained close to 20 percent of its value since election night and has easily outperformed the Dow Jones industrial average, which is itself reaching all-time highs.

But observers have been warning for months that congressional politics would make it hard for the president to achieve his defense goals, and an otherwise-giddy investor community is starting to take notice.

"There was euphoria in these early months at the generic goals Trump had laid out when he was a candidate," said MacKenzie Eaglen, a military analyst with the conservative American Enterprise Institute. But the increases announced Monday "were not historic, and the political dynamics are hardening, not softening. Everything is a party-line vote now."

To substantially expand the military, Trump will have to muster enough votes in Congress to repeal the Budget Control Act, which has capped defense spending for the past few years.

Some defense investors worry such a move could meet stiff resistance from those fighting corresponding cuts to agencies such as the Environmental Protection Agency and the State Department.

A research note from Howard Rubel, an investment banker with D.C.-based Jefferies, said the president's initial budget plan is "likely to be dead on arrival," because proposed Environmental Protection Agency and State Department cuts will alienate moderate Democrats and a lack of entitlement reform provisions will irk Republican budget hawks.

But Trump is also facing pressure from defense-minded members of the House and Senate, who say his spending plan doesn't go far enough.

Even as Trump boasted Thursday about what he is calling "one of the largest defense spending increases in American History" from atop a U.S. Navy aircraft carrier in Newport News, Virginia, high-ranking Republicans in Congress attacked his budget proposal for underfunding the military.

"With a world on fire, America cannot secure peace through strength with just 3 percent more than President Obama's budget. We can and must do better," Sen. John McCain. R-Ariz., said Monday in a statement.

Rep. Michael R. Turner, R-Ohio, accused the White House of "fake budgeting" for claiming its $54 billion budget increase would increase defense spending by 10 percent, when the plan is only 3 percent higher than what Obama had planned. And Rep. Mac Thornberry, R-Texas, chairman of the House Armed Services Committee, also called the funding level insufficient.

For all his talk about a defense buildup, Trump has also sought to cast himself as a tough negotiator determined to cut better deals for the taxpayer.

The president's targeted tweets at defense companies - such as when he threatened to cancel Boeing's Air Force One contract or replace Lockheed Martin's F-35 Joint Strike Fighter with a cheaper plane - set the industry abuzz because of the way they shifted blame for federal largesse onto the companies receiving military contracts.

"We've saved taxpayers hundreds of millions of dollars by bringing down the price of ... the fantastic - and it is a fantastic - new F-35 jet fighter," Trump said in his speech to Congress last week.

He went on to imply that the browbeating would continue: "We'll be saving billions more on contracts all across our government."

But so far it seems that the companies in his crosshairs have mostly benefited.

Each time specific companies have been the subject of his tweets their stock prices have wavered only slightly, in each case recovering lost value within a few hours. Even Lockheed Martin and Boeing, which have been the subject of highly public criticism from the president over certain contracts, have seen their stock values increase by 11 percent and 28 percent respectively since Election Day.

Trump's highly public negotiations with Lockheed Martin over the F-35 contract resulted in a contract deal that shaved $728 million from the cost of the contract and brought the unit price of the plane below $95 million for the first time, reductions that were generally in line with what the government was already planning.

It is not clear that Lockheed Martin will take much of a financial hit. In a February conference call, Lockheed Martin chief financial officer Bruce Tanner said he still expects the company's operating margins on the F-35 to increase in the coming year, even after negotiations with the president.